Ares Capital: Completes American Capital Acquisition

“NEW YORK –(BUSINESS WIRE)– Ares Capital Corporation (NASDAQ:ARCC) announced today that it has completed its previously announced acquisition of American Capital, Ltd. (NASDAQ:ACAS), enhancing its leadership position in middle market direct lending in the U.S. Ares Capital continues to be the largest business development company in the U.S. with total assets of $12.3 billion pro forma for the American Capital acquisition as of September 30, 2016.

“We are excited to close the acquisition of American Capital , which we expect will be accretive to core earnings and provide many financial and strategic benefits to our shareholders as we further enhance our scale and market position,” said Kipp deVeer, Chief Executive Officer of Ares Capital . “While significant progress was made with the American Capital portfolio after the merger agreement was signed, we expect a continued repositioning of its legacy investments to enhance earnings at the combined company and further improve our company’s outlook.”

Under the terms of the agreement, American Capital shareholders will receive total consideration of approximately $18.06 per share comprised of: (i) $14.41 per share from Ares Capital consisting of approximately $6.48 per share of cash (including a make-up dividend in the amount of $0.07 per share) and 0.483 Ares Capital shares for each American Capital share at a value of $7.93 per American Capital share (based on the closing price per share of Ares Capital common stock on January 3, 2017), (ii) $2.45 per share of cash from American Capital’s previously announced sale of American Capital Mortgage Management, LLC , and (iii) approximately $1.20 per share of cash as transaction support provided by Ares Capital Management LLC , a subsidiary of Ares Management, L.P. (NYSE:ARES) and the investment adviser to Ares Capital , acting solely on its own behalf. In connection with the stock consideration, approximately 112.0 million Ares Capital shares were issued to American Capital shareholders, resulting in American Capital shareholders owning 26.3% and Ares Capital shareholders owning 73.7% of the combined company. On January 3, 2017, the official close price of Ares Capital’s common stock on The NASDAQ Global Select Market was $16.42 per share. American Capital shares were delisted from the NASDAQ and trading ceased at the close of trading on January 3, 2017.

In connection with the acquisition, Ares Capital Management LLC has also agreed to waive up to $100 million in income based fees from Ares Capital for ten calendar quarters beginning in the second quarter of 2017. The waiver will be in an amount of up to $10 million of such income based fees in each such quarter to the extent earned and payable to Ares Capital Management , to support the expected profitability of the combined company during the integration and portfolio repositioning period.

Based on pro forma information as of September 30, 2016, the transaction increases and further diversifies Ares Capital’s portfolio of investments from $8.8 billion across 215 portfolio companies to approximately $11.8 billion across 314 portfolio companies. In addition, due to American Capital’s substantial cash position of more than $1 billion and no debt, the transaction moderately reduced the combined company’s debt to equity ratio pro forma for the American Capital acquisition as of September 30, 2016. With a larger capital base and expanded portfolio, Ares Capital also has the opportunity to increase its average commitment sizes and final investment positions over time.

The significant amount of cash held by American Capital and the resulting reduction in leverage from the transaction puts us in a strong capital position as we look to drive long-term earnings growth from the American Capital acquisition,” said Penni Roll , Chief Financial Officer of Ares Capital” .

Extract from press release

The long and winding road has ended for American Capital (ACAS). Ares Capital (ARCC) has grasped the baton.  As the press release indicates, an important but undisclosed number of ACAS-owned investments have already been sold or repaid and converted to cash in order to be re-deployed as the new manager sees fit. However, the press release is coy about the actual number, referring only to the value of the ACAS portfolio at September 30, 2016, the date on which the acquisition pivoted.  When ARCC says “we expect a continued repositioning of its {ACAS] legacy investments” going forward, the implication is that there will be still much shifting and changing in the quarters ahead.

GOOD TIMING

The good news for ARCC is that the acquisition is happening at a time when the leveraged debt markets are in a period of high spirits, which will facilitate refinancings and sales, even for some of the harder to swallow investments held at ACAS, which has been in a long, unofficial self liquidation of its assets for years.  Much of the success or otherwise of the acquisition will be what happens to the more problematic loans, control investments, long-in-the-tooth CLO portfolios and the shrinking European portfolio. The better credits will take care of themselves. We’ll be making a list and checking it twice (or more) in the quarters ahead, and try to determine if values will match what ARCC paid as of September 30, 2016 in its understandable hurry to nail down this huge acquisition.

Clearly, ARCC’s official position is that they have been bargain hunters. The press release repeats the mantra quoted from the outset that the deal “will be accretive to core earnings”.  We’ll find out soon enough because that’s an objective standard. Less easy will be counting the “many financial and strategic benefits”,  but we will try to point them out as they came into focus. Helping the merger along will be the fee waivers that the External Manager has thrown into the pot for ten quarters beginning with the IIQ of 2017. We doubt the “integration and portfolio re-positioning period” will take 10 quarters so this might be a nice fillip to ARCC’s earnings in 2018 till the measure runs out.

THE BIGGEST WINNER

Of course, the big winner from the acquisition is the External Manager (fee waivers notwithstanding) as they have acquired stewardship over another huge pool of permanent equity capital and fee earning portfolios regardless of what happens to the shareholders bottom line. We-and most everybody else-are sanguine about the ability of ARCC to turn the sow’s ear of the ACAS portfolio into a silk purse partly due to the hugely successful acquisition by ARCC of Allied Capital nearly a decade ago. Nonetheless, we still need to look at the progress on a granular level to be certain that all is as hoped for, which we’ll be doing on every possible occasion in 2017.

SO LONG, FAREWELL

For the BDC Reporter, this also marks the end of the road for our coverage of American Capital. The former sector leader has now been de-listed from the stock exchange and will be removed from our coverage universe, bringing down the number of publicly traded BDCs on our radar and in our database to forty five. It’s a bittersweet occasion as ACAS represented our very first foray into BDC investing, even before there was a BDC Reporter or even a BDC Sector to speak of, back in 1999. ACAS has been both hero and zero, and its chequered history a reminder that investors  can never take anything for granted and that hubris and corporate greed have the ability to fell even the biggest players.

OUR JOB IS TO WORRY

We are much more optimistic about the approach taken by Ares Capital and Ares Management, but cannot help having a frisson of worry when we see the enthusiasm with which the newly enlarged BDC promises to take on the very large loan underwritings that used to be the bailiwick of the banks.  Size brings its own risks to ARCC. We’ll be watching.

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